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Beware of these three big dividend payers

With the 2013 financial year reporting season coming to a close, now is a good time to look at the companies that might under- or overperform in the next 12 months.

Investors would have watched with pleasure (or envy) as reliable, income-generating stocks outperformed the ASX 200 index over the past 12 months. This was driven by record low interest rates pushing down the returns from term deposits and bonds. Companies with excess cash realised that performance of their share price could likely hinge on whether or not they returned that cash to shareholders. This is evidenced by the 10% increase in dividends announced this reporting period, while revenue and profit growth has been in low single digits.

The fact that earnings and profit have not increased meaningfully, while dividends have increase by 10%, indicates that there must be a number of companies that have declared unsustainable payouts. Of these, three ASX 200 stocks stand out to me: Coca-Cola Amatil (ASX: CCL), Insurance Australia Group (ASX: IAG), and Suncorp (ASX: SUN).

Coca-Cola Amatil announced a drop in revenue and profits for the first half of 2013 and downgraded earnings to between flat and a decline of 4% for the 2013 calendar year. The company has good cash flow and is seeing an improvement in its Asian markets, but weakness in Australia is inhibiting the company’s ability to grow earnings.

Coca-Cola announced an interim dividend of 24 cents per share, plus a special dividend of 2.5 cents per share. This has increased the payout ratio from the mid-70% of profit to around 82%. If last year’s payout is maintained, the ratio will increase towards 90% by the end of the year, generally an unsustainable level for a company which aims to grow into developing markets.

IAG announced a huge profit rise of 275% on the back of low claim numbers and a rise in insurance margin to 17.2%. This allowed the company to declare a full year dividend of 36 cents, more than double last year’s 17 cents. IAG has forecast a much lower margin of 12-14% for the next financial year, and investors should not expect that the high payout ratio of 64% will be maintained in coming years.

Finally, Suncorp reported a 32% drop in profit, but surprised with a 50% rise in dividend to 30 cents per share, and a special dividend of 20 cents. This is expected to raise its payout ratio above 80%, which is considered unsustainable in the banking sector.

Foolish takeaway

Investors should be cautious when investing in stocks purely for an income stream. If the company does not have the ability to maintain and grow dividends over the long term, then substantial losses of capital may occur when it disappoints the market. QBE Insurance (ASX: QBE) is a recent example of this, and risk-averse, income-seeking investors may be better off purchasing the banks or real estate investment trusts.

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Motley Fool contributor Andrew Mudie owns shares in Coca-Cola Amatil.

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